INVEST talks with advisors from USAID partner network members about the short and long-term needs of SMEs in emerging markets as these businesses attempt to cope with the COVID-19 pandemic and its effects. This post originally appeared in Impact Alpha.
Local textile manufacturers in North and West Africa are pivoting to meet demand for personal protective equipment. Flower growers in Kenya are switching to grow basic foodstuffs.
Small and mid-sized companies create 80 percent of Africa’s jobs, (compared to 60 percent in the United States and 50 percent in the European Union) and are at risk as the COVID-19 crisis ripples through emerging markets. Local advisors and intermediaries that straddle investment and international development in emerging markets are playing a critical role in helping them adapt, survive, and contribute to the economic recovery.
Such providers are well-positioned to connect private capital with businesses seeking new types of financing. With local offices in emerging and frontier markets, they can help foreign investors conduct due diligence on local businesses that would otherwise be impossible because of travel restrictions stemming from the pandemic.
Many of these firms are at the forefront of the COVID-19 response, rapidly finding ways to address the economic—and by extension humanitarian—challenges in developing countries.
The stakes are high. “The COVID-19 crisis is going to hit developing countries so much harder than the United States and Europe since their healthcare systems and governments don’t have the same resources to combat the crisis,“ says Saskia Bruysten, the CEO of Yunus Social Business. “Without immediate support, many social businesses and impact-first companies working to end poverty and implement sustainable development will be wiped out.”
These businesses and others around the world have an overwhelming need for advisory services, relief funds, and catalytic capital that can help them survive the coming months and years. While a new wave of government-sponsored stimulus packages have begun to address the health crisis and the economic crisis it generated, the private sector has a large role to play, too. With the right kinds of capital and transaction advisory assistance, small and medium-sized enterprises (SMEs) in frontier and emerging markets can pivot to serve the immediate needs of their communities.
VIDEO: INVEST’s Strategic Investment Advisor Noemi Danao-Schroeder discusses how INVEST works and is helping USAID missions pivot their activities to address COVID-19:
The priority is to shore up local supply chains so that they can continue to meet people’s basic needs, starting with food and healthcare. The world has seen an abrupt increase in the demand for PPE—personal protective equipment, such as masks and gloves—for those working both within and outside of hospitals. However, the surge in demand and increased difficulty in sourcing these products has left many businesses unable to get the gear they need to operate. Without a sufficient PPE supply, workers performing jobs across all supply chains are at an increased risk of falling ill.
In North and West Africa, for example, temperature-controlled food warehouses, an integral part of the food supply chain for much of the region, can’t get protective gear for their workers.
“The temperature-controlled logistics facilities we invest in can’t get PPE because they are not designated as critical-needs businesses, even though they are,” says Matthew Meredith, a managing principal at LixCap, a Morocco-based investment advisory firm that has investments in these warehouses. “If coronavirus rips through a facility in Tangier, it impacts food supply chains across Morocco. That situation is replicated across emerging markets, so we really need to see some businesses within the supply chain convert to ramping up the local production of PPE.”
Local textile manufacturers, for example, could pivot and begin producing masks, gloves, and isolation gowns. However, for such conversions to become a reality, businesses need assistance adapting their production lines and financing new equipment to meet the sudden, overwhelming demand for PPE. By modifying their services and offerings, businesses can survive and keep their workers employed even if the demand for their usual products has dried up, and they also enable businesses in other sectors to continue their operations.
Jake Cusack, co-founder of CrossBoundary, a frontier market investment advisory firm, says that many businesses looking to make these adjustments have turned to firms like his for help.
“If you’re a light manufacturer, should you now switch to producing PPE? If you grow flowers in Kenya and the global flower market has dried up, should you begin growing basic foodstuffs that can be sold locally? We are helping them think through their pivot strategies so that they can align with the new sources of demand in the economy while being mindful that some of these dynamics may be relatively short-term.”
While such course changes are especially urgent in keeping critical sectors online, businesses in every sector will need assistance to adapt to the transformed business environment. Because the pandemic and social distancing measures have resulted in decreased sales, less demand for products and services, and diminished revenues, otherwise successful businesses have found themselves in a liquidity crunch. Many will need help restructuring their capital—sometimes in dramatic ways—to survive.
Fearing defaults given the current economic climate, local banks are unlikely to lend to SMEs, especially in emerging markets that lack small business loan programs. Furthermore, SMEs struggling with liquidity issues may be increasingly wary of committing to additional monthly payments. As such, these businesses need assistance thinking through how to restructure their capital—consolidating their debt with better payment terms and attracting new equity investments—and the transaction advisory services provided by firms like CrossBoundary can help.
“We are trying to prevent otherwise good businesses from going bankrupt because of this shock,” says CrossBoundary’s Cusack. However, the businesses that most need these services the most have the least ability to pay for them at moment. “For most businesses, we are doing it pro bono, saying ‘Pay us when you can,’ or working with USAID or other donor assistance to help absorb the cost,” he says.
He’s right: international development agencies can help these SMEs by subsidizing the advisory services they need. However, in the short-term, international development agencies also must provide immediate relief capital to SMEs struggling to weather the crisis and stay afloat.
“Speed is critical,” says Vanessa Holcomb Mann of USAID INVEST, an initiative of the U.S. Agency for International Development (USAID) implemented by the international development firm DAI. Yunis, Lixcap, and CrossBoundary are members of USAID’s partner network, managed by USAID INVEST, which includes advisory firms, nongovernmental organizations, and other intermediaries that help mobilize private capital aligned with development goals.
“Some businesses have a pressing need for immediate relief capital in the form of grants or zero-interest loans from governments and donors,” says Mann. “They can’t wait three to six months for capital injections.”
However, relief capital is not a one-size-fits-all solution, and Holcomb Mann acknowledges that many businesses are still suitable for private investment, and, in the face of COVID-19, are actively looking for new sources of capital. Businesses in emerging markets are seeking strategic partnerships with U.S. investors that they have never considered before.
“We’ve had a flood of inquiries from local companies,” says LixCap’s Meredith. “They are looking to access mezzanine financing,” a financing strategy that attracts lenders because it offers higher interest payments, and, in the case of default, it allows them to convert their debt to an equity stake in the company.
“These companies have a strong fundamental business and a good management team,” he says. “They’ve never needed mezzanine financing before. They’ve always been able to get money from the banks and haven’t wanted other shareholders inside their organizations. Now, however, they are going to lose two-quarters of their revenue, and that has changed what these companies are willing to do to survive.” International development agencies can use blended finance interventions, such as providing catalytic capital (a type of financing that has better than market-rate terms and often acts as a protective layer of capital for other investors), to accelerate the flow of capital into these companies.
“Amid all the uncertainty, a lot of investors are actually sitting on cash, waiting to see what will happen,” says Holcomb Mann. “These investors, namely funds, have the capital to deploy now, and catalytic capital from development agencies can help accelerate that deployment by easing investors’ concerns over possible, unknown risks. It can move the money off the sidelines into high-impact businesses, which is important because the quicker we can get them this capital, the more robust and resilient they’ll be.”
Foundation for Recovery
By using such interventions to support SMEs, international development agencies can do more than just stop the immediate bleeding resulting from the crisis: they can put in place the supports needed for longer-term recovery and self-reliance.
“The last decades that development agencies have spent strengthening SMEs in emerging markets has laid a solid foundation for the recovery. There is confidence that the strongest of these firms will be able to pivot quickly, provide employment, and help their communities through this crisis,” says Kristi Ragan, chief of party for USAID INVEST.
However, these SMEs will only be able to contribute to the recovery if they survive long enough to evolve and gain access to the financing they need to pivot.
While the development and investment communities are working quickly to implement sizable, coordinated relief facilities and blended finance funds in support of SMEs, the scale of the crisis creates a pressing need for force-multiplying partners—partners that, with a little support, can have an outsize impact. Fortunately, those partners stand at the ready.
No blueprint exists for solving the challenges brought on by COVID-19. As development organizations work to address these challenges, no partner organization can claim decades of experience working in COVID-19 response. However, many of the less traditional commercial partners have years of insight from working on-the-ground in these SME ecosystems, thereby enabling them with the logistical and experiential know-how needed to develop tangible solutions for the current challenges.
USAID recognizes that COVID-19 threatens to destroy a generation of SMEs that the development community has long worked to support. The best chance for the survival of these businesses requires international development agencies to partner with, and listen to the ideas of, private sector actors—partners who have been supporting local SMEs for years, intimately understand their needs, and draw upon deep, market-based experience to help them solve their problems.